5Things to Know About New Zealand’s Interest Rate Decision

New Zealand on Thursday became one of the first developed nations to raise interest rates as Western economies slowly emerge from the global financial crisis. The agriculture-rich nation is going gangbusters, stoked by growing demand from China’s middle classes for dairy products and a construction boom as rebuilding intensifies after a 2011 earthquake killed 185 people. The quarter percentage-point hike, to 2.75%, is expected to be the first of many as the central bank seeks to tame rising house prices and keep a lid on inflation.

1Why did the central bank raise rates?

After three years at a record-low 2.5%, rates were simply too low for where the economy sits today. Strong dairy prices have pushed the country’s terms of trade to a 40-year high. Consumer sentiment and retail sales are robust, migration is surging and employment is improving. The Reserve Bank of New Zealand is also concerned about an overheating housing market. In October, it imposed curbs on mortgage lending—limiting the number of loans to home buyers able to make only small down payments. Easy credit in the early 2000′s fueled a housing bubble the central bank tried to control—with little success—by boosting the policy interest rate. With so much of the country’s wealth tied up in housing, when prices did eventually fall the economy dipped into recession, even before the global financial crisis.

"It is necessary to raise interest rates towards a level at which they are no longer adding to demand"

Reserve Bank of New Zealand Governor Graeme Wheeler

2Who are the winners?

Savers, who—for the first time in years—will start to see a better return for their efforts. New Zealanders are not known for spendthrift: Retail sales and property speculation have long been big drivers of the economy. Bank deposits totaling NZ$123 billion in January were dwarfed by home loans at around NZ$187 billion, according to central bank data.

7-8%
The return on Kiwi bank deposits five years ago, according to the New Zealand Bankers' Association.

3Who are the losers?

The Reserve Bank’s longstanding argument in favor of keeping rates low has been the strength of the New Zealand dollar, which is up around 3% so far this year against a basket of currencies, making it more difficult for companies in the export-dependent nation to compete globally. New Zealand accounts for a third of global dairy exports. Homeowners will also take a direct hit to their wallets, which could put a dampener on retail sales and sentiment.

4What will the central bank do next?

New Zealand’s central bank is fairly unique globally in that it essentially tells the market what its plans are. The 90-day bank bill track, widely considered a proxy for interest rates, shows that the bank plans around 2 percentage points of rate increases over the next two years.

5.3%
The expected bank bill rate in New Zealand by early 2017.

5What does it mean for the Kiwi dollar?

The New Zealand dollar shot higher against its U.S. and Australian counterparts as investors priced in more rate hikes to come. In contrast, Australia’s central bank this month signaled interest rates are likely to remain at a record-low 2.5% for much of the year to help fight rising unemployment. That interest-rate differential hurts: Australia is New Zealand’s second-biggest trade partner, with exports totaling NZ$9 billion in 2013. Around 70% of New Zealand firms expect the Kiwi to reach parity with the Aussie dollar in the next 12 months, according to a local bank survey, further tightening the screws on exporters.